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Friday, March 5, 2010

The Chained Consumer Price Index: How Is It Different, and Would It Be Appropriate for Cost-of-Living Adjustments?

Brian W. Cashell
Specialist in Macroeconomic Policy

The Bureau of Labor Statistics (BLS) of the Department of Labor publishes two important measures of inflation: the consumer price index for all urban consumers (CPI-U), and the consumer price index for urban wage earners and clerical workers (CPI-W). The CPI-W is used to adjust Social Security benefit payments, and the CPI-U is used to adjust the personal income tax brackets to keep up with inflation. As is the case with most economic indicators, the two CPIs are not without their flaws. 

The CPI might seem like just another economic indicator, but it could be a powerful policy lever. Because it is used to make automatic adjustments that affect both outlays and revenues, changing those automatic adjustments could have substantial effects on the budget deficit. Changes in those automatic adjustments could also be part of any Social Security reform proposal. 

One of the difficulties in estimating changes in the cost of living is that consumer spending patterns change continuously. Spending patterns change because of changing tastes and also because of changes in relative prices. Over time, as prices change, consumers will tend to buy more of those goods and services whose prices are rising slower than average and fewer of those goods and services whose prices are rising faster than average. This substitution is believed to result in a CPI that overstates the effect of inflation on consumer well-being. 

As part of the continuing effort to improve measures of change in the cost of living, since August 2002 BLS has been publishing a supplemental measure known as the chained consumer price index for all urban consumers (C-CPI-U). The C-CPI-U does not replace either of the current CPIs and has not affected any current indexing provisions of federal government programs. The aim of the C-CPI-U is to produce a measure of change in consumer prices that is free of substitution bias. 

Actual data for the C-CPI-U are available beginning with December 1999. Most of the time the increase in the C-CPI-U is smaller than for either of the other CPIs. Since 1999, the CPIs have ranged from 0.8 percentage point higher than the C-CPI-U to 1.1 percentage points less than the C-CPI-U. 

That the CPIs are not revised makes them attractive for use in making automatic cost-of-living adjustments. Unlike them, the C-CPI-U is subject to two revisions after its initial release. If the CCPI- U were to be used for cost-of-living adjustments, those adjustments would have either to wait until the final number was available or rely on a number that could change after the fact. Depending on the month, the final C-CPI-U is not available for as long as two years after the reference date. 

Date of Report: February 25, 2010
Number of Pages: 12
Order Number: RL32293
Price: $29.95

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